Analysis and criticism of America's most prominent public intellectual and champion of Keynesian economics. I am part of the Austrian School of Economics, and I critique Krugman's writings from that perspective.

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Monday, February 18, 2013

Raise that Teenage Unemployment Rate

If one were to read only Paul Krugman's column and blog, the reader would find many interesting things about economics. That would include things like governments make economies grow by printing money (we call that "creating demand"), only government regulators can accurately read price signals (and know the future), and that the U.S. economy as a whole behaves exactly as an alleged babysitting co-op in Washington, D.C.

Today, however, we find yet another gem in the Krugman lexicon: forcing wages above the market level not only will have no effect on employment of low-skill workers and raises real wages overall, but will be an overall plus to the economy because...it supposedly "corrects" a glitch in the earned income tax credit. Oh, and forcing up the minimum wage is "good economics."

To his credit, Krugman does not rely on the fallacy of confusing marginal measurements for total measurements, something I have heard on NPR and read in various editorials and columns. (That fallacy is to assume that if the government raises the minimum wage, then it has raised overall income, which gives people more money to spend, which creates prosperity. Yes, people have been making that argument, which is based upon the Fallacy of Composition, but I think Krugman understands that if he does try to do that, he would be jettisoning the entire Diamond-Water Paradox explanation of value which has under-girded neoclassical economics since the late 19th Century.)

Well, Economics 101 tells us to be very cautious about attempts to legislate market outcomes. Every textbook — mine included — lays out the unintended consequences that flow from policies like rent controls or agricultural price supports. And even most liberal economists would, I suspect, agree that setting a minimum wage of, say, $20 an hour would create a lot of problems.

Now, I am not sure why $20 an hour would be bad, at least if one depended upon the reasoning I have heard on NPR, the NY Times, and from other pundits, if they are insisting that it increases aggregate demand. The obvious reason -- and Krugman does not want to stray altogether from an a priori view of the laws of economics -- is that $20 an hour would have the same effect as a big agricultural price support but instead of there being a huge surplus of wheat, there would be a huge surplus of low-skilled workers not being able to find legal employment. (I am sure that my mentioning of a priori analysis is going to set off the Usual Suspects who want us to believe that there is no Law of Scarcity at all because government can do away with scarcity simply by printing and borrowing, but we should face it that when Krugman does allude to real supply-and-demand functions and how they behave, he is engaging in a priori.)

Instead, Krugman is trying apparently to make the claim that the present $7.25 an hour minimum wage probably is below true market levels and that employers are able to hire on the cheap. He declares:

First of all, the current level of the minimum wage is very low by any reasonable standard. For about four decades, increases in the minimum wage have consistently fallen behind inflation, so that in real terms the minimum wage is substantially lower than it was in the 1960s. Meanwhile, worker productivity has doubled. Isn’t it time for a raise?

There are a couple points I need to make here. First, he is saying that inflation effectively cuts wages, something nearly every economist, including John Maynard Keynes, would say and Keynes even advocated inflation precisely for its wage-cutting effects. However, Krugman in recent years also wants us to believe that inflation has a wealth-enhancing effect in that it "stimulates" economic activity and actually is necessary for economic growth.

We have a logical disconnect here. If the very thing that helps to bring about economic growth also has the bad effect of putting whole classes of workers behind, then we need to ask if economic growth is occurring at all, or if people are better off without the growth, or if economic growth as we know it is nothing more than a transfer of wealth from lower-income people to higher-income people.

Time and again we have read not only from Krugman, but also from many other "liberal" sources that over the past 30 years, income inequality has increased demonstrably and that (according to Krugman's statements on numerous occasions) real wages for the vast majority of Americans have fallen relative to where they were before 1980. For that matter, Krugman makes that argument here, along with implying that the minimum wage workers of 30 years ago are the same people working minimum wage jobs now.

So, we are left with an interesting chicken-and-egg question: does economic growth occur because of this increase in inequality, or does it occur despite the advent of economic growth? If it is because of the former, then economic growth by itself would be deemed immoral by any standards of human decency. If it is the latter, then the only logical conclusion one can reach is that overall standards of living have risen, but that the very wealthy benefit more from growth than do others.

In order to make the argument using the first point of view, one would have to demonstrate that since the advent of capitalism more than 200 years ago, standards of living for the vast majority of people have fallen, given we have seen nothing more than a wealth transfer from the poor to the rich. Not even Paul Krugman is willing to make that argument.

For that matter, he would have to say that standards of living (as measured by real wages) for the vast majority of Americans have fallen in the past 30 years ever since the top federal income tax rate was moved from 70 percent (a rate Krugman personally told me in 2004 was "insane") to 50, then 28, then 33, then 39.6, then 35, then 39.6 percent. I'm not sure that Krugman is going to try to claim that most Americans actually are poorer than they were three decades ago, but from what I see, that is his only logical conclusion. Since Krugman has argued elsewhere that the various economic "classes" in this country are rigidly stratified, and that there is little economic mobility, I don't see how he gets out of this jam.

If he uses the second argument I presented -- that overall living standards have risen, but the class of wealthy people has done better than everyone else -- then he simply is trying to say that we have had economic growth, but it has been somewhat uneven, and that goes against his own liberal sense of "fairness." But elsewhere he and others (especially Robert Reich and Joseph Stiglitz) have argued that inequality has blocked economic growth, so we are in a quandary, as Krugman and others have tried to argue against themselves -- but manage to get away with it because they are the darlings of the current political classes and their adoring media.

I have no idea how Krugman can justify logically holding to conflicting and mutually-exclusive viewpoints, but in the end he does not try to do so. Instead, he uses both arguments and expects the readers to believe both.

His second point is while logic might propose that raising the minimum wage above market levels would increase unemployment, we don't see that happening, which means that arguments against raising the minimum wage are wrong:

Now, you might argue that even if the current minimum wage seems low, raising it would cost jobs. But there’s evidence on that question — lots and lots of evidence, because the minimum wage is one of the most studied issues in all of economics. U.S. experience, it turns out, offers many “natural experiments” here, in which one state raises its minimum wage while others do not. And while there are dissenters, as there always are, the great preponderance of the evidence from these natural experiments points to little if any negative effect of minimum wage increases on employment.

Why is this true? That’s a subject of continuing research, but one theme in all the explanations is that workers aren’t bushels of wheat or even Manhattan apartments; they’re human beings, and the human relationships involved in hiring and firing are inevitably more complex than markets for mere commodities. And one byproduct of this human complexity seems to be that modest increases in wages for the least-paid don’t necessarily reduce the number of jobs.

What this means, in turn, is that the main effect of a rise in minimum wages is a rise in the incomes of hard-working but low-paid Americans — which is, of course, what we’re trying to accomplish.

His explanation (seen in the second paragraph) is a non sequitur. Yes, human beings can be complex, but either the Law of Demand, the Law of Opportunity Cost, and the Law of Scarcity hold or they do not. If a government edict calling for a rise in the minimum wage essentially can eliminate opportunity cost, then we have discovered the pathway to riches.

For that matter, if his "humans-are-complex-creatures" explanation is valid for explaining away why "studies" have shown raising the minimum wage -- even "modest" ones -- has no effect on unemployment, then why not $20 or $50 or even $100 an hour instead of the measly $9 an hour? If Krugman makes an appeal to the Law of Demand and supply-and-demand functions, then the only logical explanation would be that American employers are paying less than market wages and getting away with it.

If that is the case, then he needs to explain why they can get away with it. Instead, he offers mutually-exclusive explanations and expects readers to be awed by them, and in the last paragraph of his quote, he then tries to use the "it-raises-overall-incomes" argument. Again, this makes sense only if the current minimum wage is less than the market or "equilibrium" rate or if the current employment situation is such that the current demand for low-wage labor is inelastic.

Should current demand for that labor be elastic, then forcing up the minimum wage would result in lower overall incomes for those unskilled workers making that lowest wage. However, the current state of the economy is such that it is hard to make an argument that the demand for current labor is inelastic, for if that is the case, then there would have to be another explanation for the high levels of unemployment we see in this country.

Again, Krugman simultaneously is trying to argue two mutually-exclusive points and claiming both are true. His next argument says that raising the minimum wage has a synergistic effect with the Earned Income Tax Credit, making it work better:

Finally, it’s important to understand how the minimum wage interacts with other policies aimed at helping lower-paid workers, in particular the earned-income tax credit, which helps low-income families who help themselves. The tax credit — which has traditionally had bipartisan support, although that may be ending — is also good policy. But it has a well-known defect: Some of its benefits end up flowing not to workers but to employers, in the form of lower wages. And guess what? An increase in the minimum wage helps correct this defect. It turns out that the tax credit and the minimum wage aren’t competing policies, they’re complementary policies that work best in tandem.

This is not an economic argument, because it does not say whether or not the EIC has economic merit or not. He only says that since people of both parties support it, then it must be a good thing, which is an appeal to the ad populum fallacy. Furthermore, when one examines his argument, he is saying that something that might harm an employer is good for the worker, but that assumes that workers and employers are in competition with each other, which violates another basic tenet of economic analysis.

Moreover, there is nothing in the EIC argument that would mitigate the Great Wonders of imposing a significantly higher minimum wage than $9 an hour. If a little bit of harm to employers is a good thing, then would not a great amount of harm be great?

Unfortunately, he then comes up with a fourth argument, one that is tried-and-true in the NYT: We should raise the minimum wage because evil Republicans hate low-wage workers and are trying to keep them in poverty. He writes:

So Mr. Obama’s wage proposal is good economics. It’s also good politics: a wage increase is supported by an overwhelming majority of voters, including a strong majority of self-identified Republican women (but not men). Yet G.O.P. leaders in Congress are opposed to any rise. Why? They say that they’re concerned about the people who might lose their jobs, never mind the evidence that this won’t actually happen. But this isn’t credible.

For today’s Republican leaders clearly feel disdain for low-wage workers. Bear in mind that such workers, even if they work full time, by and large don’t pay income taxes (although they pay plenty in payroll and sales taxes), while they may receive benefits like Medicaid and food stamps. And you know what this makes them, in the eyes of the G.O.P.: “takers,” members of the contemptible 47 percent who, as Mitt Romney said to nods of approval, won’t take responsibility for their own lives.

This is not an economic argument. Instead, it is yet another cheap political appeal that is based on any number of logical fallacies. His syllogism works as such:

Therefore, anyone who opposes raising the minimum wage to $9 is evil, or at least one's belief that it is a bad thing is motivated by evil.

This is the kind of logic one expects to hear from a politician on the stump, not economic analysis from an academic economist who has received the highest honors his profession can give. However, there is even more, as economist Robert Murphy has demonstrated.

Murphy's Law?

Robert Murphy, in a couple of blog posts, takes issue with Krugman on two fronts. In this post, he notes that a Krugman vs. Krugman battle presently is brewing, as it seems that Krugman not long ago was making essentially the classic economic arguments against raising the minimum wage. (That must have been the John Bates Clark winner Krugman, which only could mean that he no longer holds to the economic views he believed when he won that award.)

In a second post, Murphy looks at the empirical arguments claimed by Krugman and others: that states that have raised their minimum wages above the national level have not experienced any problems in unemployment of low-wage workers. Murphy's post includes the unemployment rates for people in the 16-19 age bracket (and who most likely would qualify for minimum-wage jobs), comparing the rates in those states that have wage minimums above federal minimum, and those that do not.

Interestingly, of the top eight states in teenage unemployment, six have higher-than-national minimum wages, led by California. Now, one has to be careful with simple empirics like this because one cannot assume that minimum wage is the only factor in teenage unemployment, but certainly one would assume that it would be statistically significant.

12 comments:

Yeah, once I got started, I could not stop. The real problem, however, is that it takes time to explain why one disagrees with a particular point. Krugman can state the point in a sentence, but to go into the assumptions and the issues takes more space.

"Meanwhile, worker productivity has doubled. Isn’t it time for a raise [of the minimum wage]?"

I am not sure what worker productivity as measured across the entire economy has to do with the minimum wage. Methinks a discussion of the productivity of low wage workers would be more relevant, and I suspect that theirs has not grown at nearly that rate: low skill and education levels preclude it, almost by definition.

One often hears complaints about wages lagging productivity growth, but could that also have something to do with the dangers of always thinking in terms of averages and aggregates? I just wonder where exactly in the economy that growth takes place, and find it hard to believe that the workers who are actually driving those increases in productivity do not get adequately compensated therefor.

There is something else that has been bothering me for a while, and I would very much appreciate your thoughts, Professor Anderson. High productivity tends to be translated into the notion that the American worker is N times more productive, in real-world, physical terms, than his overseas counterparts. I realize that there are many economies where low capital investment does in fact mean a far lower widget output per unit of labor, but I'm guessing – cultural factors such as siestas or protestant mores notwithstanding – that a Chinese or Mexican forklift operator, for example, produces just as much as an American one. What does that mean for the low to medium skilled workers (or high-skilled ones for that matter) in the West in our increasingly “flatter” world?

Daniel, I find discussions with people with whom I disagree exhausting, as I am sure do they, to the point of not even bothering to engage them, largely due to the time and effort we are forced to devote to addressing the validity of the conflicting premises upon which we base our respective arguments.

Your point is valid. Krugman writes of across-the-board productivity, so he assumes that all American workers are more productive, so the government should order their pay to go up.

Now, if this were true, then Krugman should advocate that the government track aggregate productivity and then order all wages and salaries to rise (Or fall?) according to the percentages. This one-size-fits-all "solution" would have its own devastating effects.

If I read Krugman correctly, he is making an unsubstantiated claim that Americans are poorer now than they were 30 years ago. Somehow, I do not think that is the case.

Didn't NAFTA explicitly prove that changes in wages impact unemployment. In theory the removal of tariffs was better for the economy as a whole. In my home state of North Carolina over 41,000 textile jobs were lost because people can't move as freely as capital. Every time Krugman speaks it just reinforces the law of unintended consequences

"That fallacy is to assume that if the government raises the minimum wage, then it has raised overall income, which gives people more money to spend, which creates prosperity."

If you believe the BLS, then 1.7 million US workers are on minimum wage, out of 125 million total workers (figs from 2011, because I couldn't find 2012). That's 1.36% of the workforce sitting on minimum wage.

If you further believe that none of those will lose their jobs on a wage hike (Krugman probably does believe this), then yes there will be some overall higher total income, but not by much in the scheme of things. Of course, that extra income must come out of higher prices somewhere else in the system, but we don't know exactly where.

I hate Minimum Wage discussions as they almost always discount those who are actually affected by the policy the marginal employers and employees. And to make matters worse, they only focus on 1/2 of the transaction, the employees. What about the other half, the buyer half of employers. What happens to them when they have to account for a 9/7.5 = 1.2 or a TWENTY PERCENT increase in payroll? The answer is easy they layoff employees and/or cut products and services that would become unprofitable under the new higher wage.

Their are several studies addressing the effects of increases in minimum wage. reich berkely, cepr, (All those studies acknowledge the limitations in obtaining, extracting and analizing the data in a way to reach meaningful conclusions). Most studies indicate that the rate of unemployment does not change. But that the increase in income is only a fraction of the amount of the wage increase. This means that instead of cutting employment, hours get cut.

Krugman cites (CEPR?) which is a summary of several other studies. Detecting a bit of Bias in the CEPR study - the CEPR study claims the income / hours cut effect is not present even though several of the studies cited indicate that it is present or the data is inconclusive. I point this out since krugman is very good at citing and misstating data

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About Me

I teach economics at Frostburg State University in Frostburg, Maryland. We are located on the Allegheny Plateau, and we have cool summers and tough winters.
I am the single father of five children, four of them adopted from overseas and I have two grandchildren. My family and I are members of Faith Presbyterian Church (PCA).